A collection of often sceptical, always candid observations and insights on the US economy and large-cap equity markets. Readers have observed my style and perspective to be that "the emperor has no clothes," and that is reasonably accurate.
Postings reflect my philosophies and perspectives on economics, business and politics.

Thursday, December 02, 2010

Distributing Starbucks Coffee: Kraft Vs. SBUX

At last there's a terrific marketing story in the news. Starbucks and Kraft are wrangling over the control and value of the distribution channel for the former's ground coffee through grocery stores.

According to an article in Monday's Wall Street Journal, the two parties inked a deal back in 1998, renewed in 2004, which has no expiration date, and puts Kraft in charge of distributing Starbucks' packaged coffee products through grocery channels. Kraft pays Starbucks fees related, in part, to sales, but essentially keeps the rest of the profits, in consideration for its doing the work of selling and distributing the coffee.

Now, like many vendors who began with weak distribution capabilities, for which they paid stronger distributors or retailers, Starbucks wants to take control of the channel back. But that pesky, perpetual agreement with Kraft stands in the way.

So Starbucks has begun to exercise its rights under the agreement to accuse Kraft of some fairly groundless- no pun intended- damages. The coffee roaster is criticizing how Kraft has done its marketing and claims it hasn't been included in discussion about the channel's management. Then the Seattle giant told Kraft that its earlier breach of contract accusations hadn't been remedied, so it was ending the agreement.

The Journal article notes that Starbucks' claim that Kraft has harmed it is belied by the strong sales growth- rising ten-fold since 1998. Causing further confusion, senior Starbucks executives are on record complimenting Kraft for its successful efforts on the coffee roaster's behalf.

Apparently, one remedy would be for Starbucks to buy the Kraft operations at a "market" price plus some premium.

Estimates of the channel's value, of course, vary. But they include one of around $1.5B. Then, the piece observes, Starbucks would have to replace Kraft's channel investments and efforts with its own, costing even more money.

This is, at heart, an old marketing conundrum. Producers give away large amounts of control and sweet terms when initiating various activities. Channels of distribution are risky, expensive and difficult to create from scratch. When a large, successful company like Kraft has a functioning channel, it makes sense to rent it, albeit at a high cost.

Years later, then the brand is established, the producer typically attempts to wrest control back from the distributor.

Manufacturers' reps face this situation all the time. As a result, they charge high margins for their efforts, knowing they will lose the successful brands down the road, while the failures won't pay them very much.

In this case, Kraft didn't plan to lose the brand franchise. Starbucks evidently only came to realize later what it had ceded to the food giant. It seems rather short-sighted for Starbucks to pick this particular fight, when it probably could have engineered a smoother transfer of the channel ownership over time. But that doesn't seem to be Howard Schultz' way.

I'm going to be very interested to see how this one develops. No doubt much of the case will turn on the exact wording of the written agreement between Kraft and Starbucks which, of course, is not currently public. From what I've read, though, so far, I'd put my money on Kraft in this fight.

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About Me

A well-educated veteran of US corporate strategy positions & hedge fund management, as well as research, product development and project work in consulting, strategy and equity management. Academic background in marketing, strategy, statistics and economics.
Currently own Performance Research Associates, LLC, through which I am involved in proprietary equity and equity options investment management.